Silven Industries, which manufactures and sells a highly successful line of summ

Question

Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin After considerable research, a winter products line has been developed. However, Silven's president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated. The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $90,000 charge for fixed manufacturing overhead will be absorbed by the product under the company's absorption costing system Using the estimated sales and production of 100,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box: Direct material Direct labor Manufacturing overhead Total cost $3.60 2.00 1.40 $7.00

Explanation / Answer

1) Manufacturing overhead per box = $1.40

Total manufacturing overhead for 100,000 boxes = $1.40*100,000 boxes = $140,000

Allocated fixed manufacturing overhead = $90,000

Variable manufacturing overhead = $140,000-$90,000 = $50,000

Variable manufacturing overhead = $50,000/100,000 = $0.50 per box

Manufacturing cost it will be able to avoid by buying tubes from outside suppliers

Decrease in Direct materisl cost = 25% of $3.60 = $0.90

Decrease in Direct Labor = 10% of $2.00 = $0.20

Decrease in variable manufacturing overhead = 10% of $0.50 = $0.05

Total decrease in cost = $0.90+$0.20+$0.05 = $1.15

2) Calculation of financial advantage(disadvantage) per box:-

Decrease in total cost per box = $1.15

Less:Purchase price of empty tubes per box = ($1.35)

Financial Advantage(disadvantage) = ($0.20)

Thus there is a financial disadvantage of $0.20 per box of chap off if Silven buys its tubes from the outside supplier.

3) Financial disdvantage in total = 100,000 boxes*$0.20 = $20,000

4) The Silven industries should make the tubes as there is a financial disadvantage of $20,000 of buying the tubes from outside supplier.

5) The maximum price that Silven should be willing to pay the outside supplier for a box of 24 tubes will be equal to the total decrease in cost due to buying a box from outside (i.e. $1.15). Thus the maximum price will be $1.15.

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